Where Do You Get Better Returns For Short Term Savings? A Bank CD Or A Lending Club Account?

The other day I was looking at my Lending Club account and reveling in my current 11.45% net annualized return, and I started to think about how the returns were so much better than what I was getting from my savings account or CDs at a traditional bank.

While there is the added risk of investing in peer-to-peer lending, if you manage your risk properly, you'll easily be able to make in excess of 10% returns. So the question is, why don't more people use Lending Club like they would a regular savings account or CD when they won't be touching the money for a few years anyway? Why not use Lending Club and set up something similar to a CD Ladder?

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Returns On Investment – CD, Savings Versus Lending Club

So let's look at what kind of returns you can expect to receive from a CD account. Let say that I invested my money in anywhere from a 3 to a 5 year CD from one of my favorite online banks – Ally Bank. You could expect to see returns in the range of 1.35% (3 year) to 1.74% (5 year). So let's say that you put $10,000 in the 5 year CD at a rate of 1.74%. After five years you would see that money grow to be about $10,908 or so. So you'd see a return of about $908 for leaving your money in the account for 5 years. Not exactly impressive. Putting your money in a 3 year CD at 1.35% would net you about $555 or so.

Now, let's say you take that same $10,000 and put it in a savings account. Most savings accounts aren't earning more than 1% right now. Let's use my Ally Savings account that I currently have our emergency fund in – it's earning .84%. So let's say we put our $10,000 in there for 5 years, we'll see gains of $430 in that savings account over 5 years. Saving for 3 years would only net us $256.

Now let's look at my Lending Club account. If I had $10,000 invested there over the same time frames, earning my current rate of interest (11.45%) I'd be seeing returns of about $4,338 for 3 years, and $8,230 for 5 years. That is quite a difference! Even if we just use Lending Club's advertised average return of 9.6%, you would still see returns anywhere from $3,495 t for 3 year to $6,481 for 5 year.

So to recap, here are the returns you would see at current rates

Savings Account: $256 (3 years)

Savings Account: $430 (5 years)

3 Year CD: $555

5 Year CD: $908

Lending Club – Average Returns: $3,495 (3 years)

Lending Club – Average Returns: $6,481 (5 years)

Lending Club – My Rate Of Return: $4,338 (3 years)

Lending Club – My Rate Of Return: $8,230 (5 years)

Admittedly these numbers aren't 100% as rates change, Lending Club loans have defaults and other things, but it gives a general idea of how great the difference would be. The difference for a 5 year Lending Club account at my current rate, and a 5 year CD would be around $7,322. The difference for a savings account is even greater at $7800. That's a nice chunk of change!

Downsides Of Using Lending Club Versus Bank Accounts

Of course there are downsides to putting your money with Lending Club. Here are a few of them:

No FDIC insurance: With Lending Club your money isn't FDIC insured, so you could always lose it all if all your loans defaulted, or something else crazy happened. The likelihood of that happening, however, is pretty low.

Low liquidity: With Lending Club your money isn't very liquid. In order to get access to the money you'd have to sell your notes on the secondary market, most likely for less than they're worth. Of course there are penalties for withdrawing money from a CD early as well. But I wouldn't recommend putting money there unless it wasn't money you didn't need right away.

A bit more work: It may take you longer to find enough loans to buy with your $10,000 initial investment. The time it takes could mean lower returns during that time period. It will also be more work than just transferring your money over to a savings account or CD. You'll have to actively find and buy loans to add to your portfolio.

Despite the downsides above, I still think the awesome returns you can see with a Lending Club account are well worth the added risk and work associated with having an account.

Of course the other option is to take that $10,000 and invest it in a low cost index fund with Vanguard or another investment account, but I think it's not a bad idea to add Lending Club to a diversified investment strategy – of which stocks and peer to peer lending are a part.

What are your thoughts? Have you considered taking money that may have traditionally just sat in an CD or savings and moving it to Lending Club?

Comments

I recently wrote comparing Lending Club notes with CDs as well. I think we came to about the same conclusions. I think the key sticking point for many is the lack of FDIC insurance, but I’m hoping that as Lending Club becomes more established, more people will take advantage of the good rates that are available through them.

Yeah, I think people still view Lending Club and Prosper with a suspicious eye – like there has to be a catch somewhere. The only catch is that you’re investing, there is no FDIC insurance and that there is a chance you could lose money. Recent history has shown, however, that diversified lenders do pretty well.

We would love to have you make a similar investment in Prosper.com and compare and contrast your experience with that of Lending Club. Prosper.com investors have consistently made double digit returns since July 2009, so your readers might find a comparative experience enjoyable reading.

Let me know if there’s any information we can supply to you to help make your experience easier.

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